Friday, February 13, 2009

A response to Axil on Economic Cycles

Axil commented on my yesterday's post on the possibility that we wereentering a depression:

What is your opinion of the Kondratieff Cycle? IMO, there may be something to it. If the 54-60 year cycle is based on generation aspects, then it would naturally be 'stretched' beyond 60 years. Since these cycles of wars and economic birth and renewal occur every 2-3rd generation, we can say that when the generation to last see a depression dies off, it's time for another cycle to begin. Our great credit bubble of the last 60 years is being washed away at the very trough predicted by the Kondratieff wave.

Here is my response:Axil, an interesting idea. It is clear to me that during the 19th century, there were several waves of investment driven economic growth followed by sharp and painful contractions. The expantions ended when capacity grew to such a point that investments failed to return borrowed money. At that point investors lost significant amounts of money, and no further investments in capacity were undertaken, because it would have ben highly irrational to do so. The last such episode was the great depression of 1929. Boom and bust cycles did not stop, but they became localized. I witnessed one such cycles in the Dallas real estate market during the late 1970's and early 1980's. The Dallas economy at that time was dominated by three big banks and smaller but ambitious savings and loans. Dallas was growing so banks began to make more and more loans for speculative construction of office towers while the S&Ls financed a speculative housing market. Loan officers completely lost sight of the probable future demand. The speculative economy convinced everyone that the boom would go on forever, and that there was no downside. Eventually it became clear that office and home construction in Dallas greatly exceeded the demand. The Banks and S&Ls went bankrupt, and the banking insurance agency drained their funds bailing out Dallas depositors. Had that boom been national This contraction hurt the Dallas economy for anumber of years, but eventually a new wave in telecommunications picked up the slack. That wave in turn went through its own boom and bust cycle. Huge amounts of money were lost in fiber optics investments, for example. Cell phone manufacture was a booming business for a while in Dallas, until production shifted off shore.Spy argues that our problem is not too little production capacity but too much. Too much investment in under utalized production capacity, with Americans borrowing too much in order to consume. But the Chinese save too much while under consuming.

My assessment of the current cycle is that Asian investments in production capacity have exceeded the saturation point. Asian economies are frequently characterized by irrationally high saving rates, so they lack the economic development to consume goods produced locally. As a consequence goods must be sold abroad, but there is a limit to the ability of non-Asian markets to consume Asian made goods. The united States was exporting industrial jobs to China, thus giving up the ability to pay for the goods it bought from China through trade. The Asians basically loaned the money to their customers to pay for the Asian produced goods. American financial institutions turned to speculative investments to make profits. The ultimate driver for those speculative investments was the loans from China, secured by the credit of the United States Government. Eventually foreclosures of speculative subprime housing loans, started a collapse of the speculative investment driven economy. At that point, it seems to me that conditions were ripe for an international depression, of which we are now seeing the early stages. I lack the wisdom to say that this account is certainly true, but this is the way I try to make the events in my world intelligible to myself.

The solution would be for China to develop a consumer economy, so that the people of China will drive in their EVs to Wal-Mart to buy all those 60" LCD TV sets and microwave ovens that China now produces. 1.3 billion Chinese consumers can certainly pull the world out of depression. Meanwhile the United States should put up trade barriers and begin rebuilding its economy. (Did I just say that? Did I just utter the "P" word?)